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Experts warn that the Brexit vote comes with a worse scenario than just the UK leaving the EU

Rayhanul Ibrahim
Anti-capitalist protesters rest in the central square in Frankfurt's old town March 18, 2015, after the inauguration of the European Central Bank (ECB) new headquarters. Anti-capitalist protesters clashed with riot police near the new headquarters of the European Central Bank (ECB) in Frankfurt on Wednesday and set fire to barricades and cars, casting a pall over the ceremonial opening of the billion-euro skyscraper. REUTERS/Kai Pfaffenbach (GERMANY - Tags: BUSINESS CIVIL UNREST)

In isolation, Britain voting to exit the European Union isn’t expected to have too profound of an effect on global markets.

However, the big risk is actually the likelihood of contagion — the UK’s successful exit could encourage other EU countries such as Spain, France, Greece, etc. to follow the UK's lead and leave. This would have negative economic effects for both Europe and the rest of the world, due to the turmoil it would cause.

The first thing to note about this possibility is that there would likely be a waiting period after the Brexit vote. This is because other eurosceptic countries would want to see what happens to the UK, and what sort of trade deal they end up getting, before they have their own referendums. This would take a minimum of two years, but may take even longer. Canada initiated negotiations for a free trade agreement with the EU back in 2009, and it has still not been ratified.

Morgan Stanley maps out the 4 possible Europe wide repercussions in the chart below:

Repercussions of the Brexit vote. (Image: Morgan Stanley)

The absolute worst possible outcome is where Europe breaks up, and the euro itself ceases to exist, which is in the bottom left corner. In such a scenario, Morgan Stanley sees European markets falling as much as 25%-30%, and the euro weakening significantly. However, this is a worst-case scenario.

Morgan Stanley isn't alone warning about this possibility. Bond fund manager Jeffrey Gundlach, whose base-case scenario is for Britain to vote "remain," says that a "leave" vote would be "the beginning of the end of the euro zone."

There are lots of Europeans who aren't too crazy about the EU. (Image: Pew Research Center)

The risk for Brexit emboldening euroscepticism is also very real — Pew Research found the unfavorability rating for the EU in multiple countries is already worryingly high.

France is especially problematic, given that it is the second largest economy in the EU. The other two big economies, Germany and Spain, are also essentially even in terms of favorability.

"The potential for additional referendums could be more disconcerting if it threw the notion of a unified European economy into doubt," Citigroup analyst Tobias Levkovich said. "In this respect, the Brexit vote itself is less important than a series of follow-on votes around the Continent."

Despite this, Pew did find that a very large majority, around 70%, of the overall EU population still believes that Brexit would be bad for the EU. People may disapprove of how the EU is doing right now, but that doesn’t necessarily mean they want to leave it just yet.

Given that actual referendums aren’t likely to take place until people see more the longer-term results of Brexit, tracking negative sentiment towards the EU over the coming months (regardless of which way the vote goes) is critical for all investors.

In fact, Levkovich believes increasing euroscepticism would likely be a big negative for American investor sentiment as well, even though the US’s direct sales exposure to Europe is not incredibly high.

So, while there are plenty of ways to downplay the Brexit vote, there seems to be no shortage of uncertainties that are being born out of it.

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